You May Not Have Until December 31, 2018 to Avoid Losing the Alimony Deduction

By Russell Smith of Fitch Law Partners LLP posted in Divorce & Family Law on Friday, February 16, 2018.

One of the new provisions of the new tax reform bill - background here - is that the long-standing tax deduction for alimony will no longer be available for separation agreements and divorces obtained after December 31, 2018. Specifically, the reform applies to "any divorce or separation instrument . . . executed after December 31, 2018" (emphasis added).

The first thing parties should know is that executing (signing) a separation instrument (separation agreement) does not necessarily mean you are divorced. It also does not mean the separation agreement is valid and "final." Separation agreements must be presented to the court and entered either as a surviving agreement, which are generally cannot be modified by the Court, or a merged agreement, which can be under certain standards (or a mix of both). As a result, the ability to get "grandfathered in" and avail yourself of the tax deduction by signing a separation agreement on or shortly before December 31, 2018 creates potential risks for the unwary in Massachusetts. Parties who are interested in minimizing their tax liabilities should not wait.

First, there is a possibility that an agreement may be signed on or before December 31, 2018 but not heard until afterward. At present, it is unclear whether and for how long the Courts will be willing to incorporate or merge separation agreements dated before the tax reform deadline into later judgments. Given the likely glut of agreements negotiated and executed in December 2018, there may be a significant delay in being heard, which could be exacerbated by extenuating circumstances. It is not unusual for parties to execute a separation agreement and not have it heard for a month or two, but longer delays potentially create questions about whether the agreement was actually signed in December. While it seems reasonable to conclude that the Courts will be skeptical of an agreement dated December 31, 2018 that is being presented in, say, June 2018, it is not clear what degree of scrutiny will be applied to such agreements or whether Courts will be required to allow such agreements based solely on the parties' representation that the agreement was in fact signed on December 31, 2018. It seems inevitable that Courts will, at some point in the future, refuse or be unable to sign off on late-filed agreements dated December 31, 2018 -- how soon that becomes the case remains an open question and may vary depending on the circumstances.

Similarly, the requirement that an agreement be "executed" before December 31, 2018 raises questions about separation agreements which are drafted and signed before that date, but which are modified between the date of execution and a hearing date that occurs after the deadline. It is not uncommon for there to be a few last-minute edits to a separation agreement, but how extensive edits would have to be in order to prompt a Court to question the date of execution is unclear. Whether the mere existence of hand-written edits in an agreement dated in late December will be enough to raise a concern is uncertain. There may be circumstances where more obvious indications of edits after December 31, 2018 exist, but to what extent proof that edits post-date December 31, 2018 will be necessary to raise judicial scrutiny is uncertain. Unless there is general guidance issued by the Court administrators, these questions will likely be answered on a case-by-case basis.

Even assuming that a separation agreement signed in December 2018 is brought before the Court in January 2019, without edits, there are still risks. Separation agreements are, in some ways, an unusual species of contract. Although negotiated and agreed to between parties (on their own or with the assistance of counsel), every separation agreement must clear two hurdles before it is a valid and enforceable contract.

First, it must be approved by the Court as "fair and reasonable." In exercising this power, the Court may ask the parties to modify provisions that are unclear or otherwise problematic. In rare cases, the Court may reject the substantive provisions as inherently unfair and unacceptable. These rejections are typically corrected within the separation agreement on the spot and without changing the date. However, if the Court required a substantial modification of the agreement, particularly as to the alimony provision, it is possible that the agreement may have to be re-dated, with the consequence of losing the ability to use the deduction. Similarly, it is not unforeseeable that a divorcing couple rushing to meet the December deadline might run into Court with a hastily drafted agreement only to have it completely rejected.

Second, each party must answer the "colloquy" at the hearing - a series of questions, asked by the Court and designed to ensure that both parties prepared and received reasonable, accurate financial disclosures, had the opportunity to consult with counsel, weren't pressured into signing the agreement, and, importantly, believe themselves that the agreement is "fair and reasonable" given their circumstances. Accordingly, a Court cannot enforce a separation agreement if one party decides, at the last minute, that it isn't fair to them. If the agreement is signed in late 2018, but isn't presented until 2019, then the approval of a separation agreement could be held up entirely by one spouse and, with it, the tax deduction reducing the alimony-paying spouse's tax burden. It's not hard to imagine an alimony-recipient spouse spotting that leverage and making (or trying to make) use of it.

In short, the Tax Cuts and Jobs Act's "execution" requirement connects imperfectly with the requirements for a valid, enforceable separation agreement under Massachusetts law. In doing so, the new tax reform bill leaves several important, consequential questions without good answers; questions that will, barring official guidance from the administrators of the Probate and Family Court, have to be answered on a case-by-case basis.